What is Margin Valuation Adjustment (MVA) and why has it become important?

Question

AcadiFi · Accepted Answer

Margin Valuation Adjustment (MVA) represents the cost of funding initial margin (IM) that must be posted over the life of a derivative trade. It has become critically important since the introduction of **mandatory bilateral margin requirements** (UMR) for non-centrally cleared derivatives, starting in 2016 and fully phased in by 2022.

**Why MVA Exists**

Before UMR, most bilateral OTC derivatives required only variation margin (VM). Now, both parties must also post initial margin — typically in the form of high-quality liquid assets like government bonds. This IM is segregated with a custodian and cannot be rehypothecated, meaning the posting party loses the ability to use those assets for other purposes.

The cost of financing this locked-up collateral over the life of the trade is the MVA.

**MVA Formula**

MVA = integral from 0 to T of [IM(t) x s_F(t) x D(t)] dt

Where:
- IM(t) = Expected initial margin at time t (computed via ISDA SIMM or CCP methodology)
- s_F(t) = Funding spread (cost of funding above risk-free rate) at time t
- D(t) = Discount factor at time t

In practice, this is computed by Monte Carlo simulation across the trade's life.

**Simplified Example**

Northbridge Derivatives enters a 5-year interest rate swap with notional $200 million. The ISDA SIMM model estimates:

| Year | Expected IM | Funding Spread | Discount Factor | Annual MVA |
|------|------------|---------------|----------------|------------|
| 1 | $4.2M | 1.20% | 0.96 | $48,384 |
| 2 | $3.8M | 1.25% | 0.92 | $43,700 |
| 3 | $3.1M | 1.30% | 0.89 | $35,867 |
| 4 | $2.3M | 1.35% | 0.85 | $26,393 |
| 5 | $1.2M | 1.40% | 0.82 | $13,776 |
| **Total** | | | | **$168,120** |

This $168K represents the present value cost of funding the IM over 5 years. It should be charged to the client at inception or included in the swap spread.

**Key Drivers of MVA:**
- **Trade maturity:** Longer trades = more IM periods = higher MVA
- **Funding cost:** Banks with higher credit spreads face larger MVA
- **SIMM sensitivity:** Trades with high risk factor sensitivities require more IM
- **Netting and diversification:** More trades in a netting set can reduce marginal IM

**Exam Tip:** MVA is always a **cost** (unlike DVA which can be a benefit). It incentivizes banks to clear through CCPs (where IM requirements may be lower) or to compress and net their bilateral portfolios.

Explore our FRM Part II XVA materials for more depth.

What is Margin Valuation Adjustment (MVA) and why has it become important?

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